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Subject: Economics

  • [pib] PMFME Scheme

    The centrally sponsored Pradhan Mantri Formalization of Micro food processing Enterprises (PMFME) Scheme, launched under the Aatmanirbhar Bharat Abhiyan marks the completion of its one year.

    PMFME Scheme

    • The PMFME Scheme is a centrally sponsored scheme that aims to enhance the competitiveness of existing individual micro-enterprises in the unorganized segment of the food processing industry.
    • It aims to enhance the competitiveness of existing individual micro-enterprises in the unorganized segment of the food processing industry and promote formalization of the sector,
    • It further aims to promote formalization of the sector and provide support to Farmer Producer Organizations, Self Help Groups, and Producers Cooperatives along their entire value chain.
    • The scheme envisions to directly assist the 2,00,000 micro food processing units for providing financial, technical, and business support for upgradation of existing micro food processing enterprises.

    Major component of the scheme

    One District One Product

    • Under the One District One Product (ODOP) component of the PMFME Scheme, the Ministry of Food Processing Industries approved ODOP for 137 unique products.
    • The GIS ODOP digital map of India has been launched to provide details of ODOP products of all the States and UTs.
    • The digital map also has indicators for Tribal, SC, ST, and aspirational districts.
    • It will enable stakeholders to make concerted efforts for its value chain development.

  • Privatisation of public sector enterprises in India

    The article suggests the privatisation of public sector enterprises by analysing their performance and devising strategy for privatisation accordingingly.

    Three categories of public sector enterprises

    1) Sick for long time and beyond redemption

    • There is the category of enterprises which have been sick for a long time.
    • Their technology, plants and machinery are obsolete. 
    • They should be closed, and assets sold.
    • The labour in these enterprises have had a political constituency which has prevented closure.

    What should be done with these enterprises?

    • The Government should close these in a time-bound manner with a generous handshake for labour.
    • After selling machinery as scrap, there would be valuable land left.
    • Prudent disposal of these plots of lands in small amounts would yield large incomes in the coming years.
    • All this would need the creation of dedicated efficient capacity as the task is huge and challenging.
    • These enterprises may be taken away from their parent line Ministries and brought under one holding company.
    • This holding company should have the sole mandate of speedy liquidation and asset sale.

    2) Financially troubled but can be turned around

    • Private management through privatisation or induction of a strategic partner is the best way to restore value of these enterprises.
    • Air India and the India Tourism Development Corporation (ITDC) hotels are good examples.

    What should be done with these enterprises?

    • Air India should ideally be made debt free and a new management should have freedom permitted under the law in personnel management to get investor interest.
    • As valuation rises, the Government could reduce its stake further and get more money.
    • If well handled, significant revenues would flow to the Government.

    3) Profitable enterprises

    • Pragmatism instead of ideology should guide thinking about them.
    • The Chinese chose to nurture their good state-owned enterprises as well as their private ones to succeed in the domestic and global markets by increasing their competitiveness in cost, quality, and technology.
    • The Chinese chose to promote both their public as well as their private sector enterprises to rise.
    • Both have made China the economic superpower that it is today.

    What should be done with profitable enterprises?

    • The Government can continue to reduce its shareholding by offloading shares and even reducing its stake to less than 51% while remaining the promoter and being in control.
    • Calibrated divestment to get maximum value should be the goal instead of being target driven to get a lower fiscal deficit number to please rating agencies.
    • In parallel, managements may be given longer and stabler tenures, greater flexibility to achieve outcomes, and more confidence to take well-considered commercial risks.

    Challenges

    • First, the number of Indian private firms which can buy out public sector firms are very few.
    • Their limited financial and managerial resources would be better utilised in taking over the large number of private firms up for sale through the bankruptcy process.
    • Then, these successful large corporates need to be encouraged to invest and grow both in brownfield and greenfield modes in the domestic as well as international markets.
    • Sale at fair or lower than fair valuations to foreign entities, firms as well as funds, has adverse implications from the perspective of being ‘Atma Nirbhar’.
    • Again, greenfield foreign investment is what India needs and not takeovers.
    • Public sector enterprises provide for reservations in recruitment.
    • With privatisation, this would end and unnecessarily generate social unrest.

    Conclusion

    Would it be in India’s interest to lose the strategic capacity that its ownership of public enterprises including financial ones provide it? It would be better to think carefully now.

  • [pib] India to become self-reliant in Phosphatic Fertilizers

    The Department of Fertilisers is ready with an Action Plan to make India Aatmanirbhar in Rock Phosphate, the key raw material of DAP and NPK Fertilizers.

    What are Phosphatic Fertilizers?

    • Phosphorus is the eleventh most abundant element on the earth. Commercial phosphate fertilizers are manufactured using phosphate rock.
    • Approximately two-thirds of the world’s phosphate resources are derived from sedimentary and marine phosphate rock deposits.
    • Ground rock phosphate has been used as a source of phosphorous for soils in the past.
    • However, due to the low concentration of phosphorous in this native material, high transportation costs, and small crop responses, the usage of rock phosphate has reduced considerably in agriculture.
    • On the other hand, the usage of phosphorous based fertilizers has grown significantly.

    Which are the most common Ph fertilizers?

    • The most commonly used phosphatic fertilizers are Diammonium Phosphate (DAP), Monoammonium Phosphate (MAP), NPKs, and SSP.
    • DAP is the world’s most widely used phosphorus fertilizer. It is popular due to its relatively high nutrient content and its excellent physical properties.
    • DAP is an excellent source of phosphorus (P) and nitrogen (N) for plant nutrition.
    • It provides the correct proportion of phosphorous and nitrogen for the farming of grains such as wheat, barley, fruits, and vegetables.
    • NPKs, also called compound fertilizers, are fertilizers that contain all three nutrients, nitrogen, phosphorus, and potassium in different proportions.

    Also read

    [pib] Nutrient Based Subsidy (NBS) for Phosphatic & Potassic (P&K) Fertilizers

    Why need Phosphorus?

    • Phosphorus is an essential nutrient required for plant growth. It helps in root development, plant maturation, and seed development.
    • If soils are deficient in phosphorus, food production becomes restricted, unless the nutrient is added in the form of fertilizers.
    • Hence, to increase food production, an adequate amount of phosphorus is required.
    • Along with nitrogen and potassium, phosphorus is one of the most important elements for plant life.
    • Soil gets depleted of phosphorus due to several reasons including being washed away by rain. Therefore, modern farming is reliant on the use of phosphorus-based fertilizers.

    Consumption in India

    • Rock Phosphate is the key raw material for DAP and NPK fertilisers and India is 90% dependent on imports.
    • Volatility in international prices affects the domestic prices of fertilisers and hinders the progress and development of the agriculture sector in the country.

    Answer this PYQ in the comment box:

    Q.What are the advantages of fertigation in agriculture? (CSP 2020)

    1.Controlling the alkalinity of irrigation water is possible.
    2. Efficient application of Rock Phosphate and all other phosphatic fertilizers is possible.
    3. Increased availability of nutrients to plants is possible.
    4. Reduction in the leaching of chemical nutrients is possible.

    Select the correct answer using the code given below:
    (a) 1, 2 and 3 only

    (b) 1,2 and 4 only

    (c) 1,3 and 4 only

    (d) 2, 3 and 4 only

  • Fighting hunger needs fighting climate change

    The article suggests pathways to achieve SDG-2 by the adoption of climate-friendly agriculture practices.

    Food and SDG

    • Food is a common thread linking all 17 UN Sustainable Development Goals (SDGs) and critical to achieving overall goals within the timeframe.
    • NITI Aayog recently released the SDG India Index 2020-21, highlighting the national and states’ progress on SDGs.
    • The report states that 34.7% children aged under five in India are stunted.
    • 40.5% of children between 6-59 months are anaemic.
    • 50.3% of pregnant women between 15-49 years are anaemic.
    • India shares a quarter of the global hunger burden.
    • Four out of 10 children in India are not meeting their full human potential because of chronic undernutrition or stunting.
    • NFHS-5 shows many states have not fared well on nutrition indicators.
    • In addition to the malnutrition challenges, India’s food system faces negative consequences of the Green Revolution technologies.

    Pathways to follow in meeting the targets under SDG-2 (Zero Hunger)

    • Crop diversification especially in those areas where the existing practices are ecologically unsustainable should be promoted.
    • While Indian agriculture is a significant contributor to GHG emissions.
    • As per third Biennial Update Report submitted by Government of India to UNFCCC, agriculture sector contributes 14% of the total emissions.
    • Some of the climate-smart interventions like conservation agriculture, organic farming and agro-ecological approaches can effectively address the environmental concerns while ensuring food security and nutrition.
    • Crop-residue burning has become a huge problem in parts of the country.
    • This is mainly propelled by monoculture and a package of subsidies.
    • Conservation agriculture offers solutions to such problems with good agronomy and soil management such as zero-tillage or no-till farming, crop rotation, in-situ crop harvest residue management/mulching, etc, and industrial uses like baling and bio-fuel production.
    • Use of botanical pesticides, green-manuring, biological pest control, etc. are nature-friendly and such practices lead to eco-conservation.
    • The organic movement, fortunately, is catching up in Sikkim, Himachal Pradesh, and a few other states.
    • Modifying consumer behaviour forms an essential ingredient to transform Indian food systems and correlate positively with crop and diet diversity.
    • POSHAN Abhiyaan, India’s national nutrition mission, can play an effective role in addressing the issues of persistent malnutrition.
    • According to FAO estimates, 40% of the food produced in India is either lost or wasted in every stage of supply chain.
    • Winning the fight against food loss and waste can save India $61 billion in 2050 through increased industry profitability and reduced food insecurity, as well as reduced GHG emissions, water usage, and environmental degradation.
    • Shifting towards a circular economy can enable India progress towards the SDGs including halving food waste by 2030 and improving resource efficiency.

    Conclusion

    India’s success is essential to achieve the planetary goal of Zero Hunger. There is a need for transformation towards sustainable, nutritious and resilient food systems to achieve the goal of zero hunger.

    Source:-

    https://www.financialexpress.com/opinion/fighting-hunger-needs-fighting-climate-change/2279369/

  • Digital Millennium Copyright Act

    Union Minister for Electronics and Information Technology was locked out of his Twitter account for an hour allegedly over a notice received for violation of the Digital Millennium Copyright Act (DMCA).

    Why such a move by Twitter?

    • The DMCA oversees the implementation of two 1996 treaties signed by World Intellectual Property Organization (WIPO) member nations.

    What is the DMCA?

    • The Digital Millennium Copyright Act, or DMCA, is a 1998 law passed in the US and is among the world’s first laws recognizing intellectual property on the internet.
    • The law oversees the implementation of the two treaties signed and agreed upon by member nations of the World Intellectual Property Organization (WIPO) in 1996.
    • WIPO members had then agreed upon two treaties, namely the WIPO Copyright Treaty and the WIPO Performances and Phonograms Treaty.
    • The said protection, accorded by each member state, must not be any less in any way than the one being given to a domestic copyright holder.
    • Further, it also obligates those signatories to the treaty to ensure ways to prevent circumvention of the technical measures used to protect copyrighted work.
    • It also provides the necessary international legal protection to digital content.

    What is WIPO and how does it ensure the protection of content on the internet?

    • The rapid commercialization of the internet in the late 1990s started with static advertisement panels being displayed on the internet.
    • It became important for website owners to get the user to spend more time on their webpage.
    • For this, fresh content was generated by creators and shared over the Internet.
    • The problem started when the content would be copied by unscrupulous websites or users, who did not generate content on their own.
    • Further, as the Internet expanded worldwide, websites from countries other than the one where the content originated, also started to copy the unique content generated by the websites.
    • To avoid this and bring to task the unauthorized copiers, the members of WIPO, which was established in 1967, also agreed to extend the copyright and intellectual property protection to digital content.
    • As of date, 193 nations across the world, including India, are members of WIPO.

    Who can generate a DMCA notice and how are they sent to companies or websites?

    • Any content creator of any form, who believes that their original content has been copied by the user or a website without authorization can file an application citing their intellectual property has been stolen or violated.
    • Users can either approach the website on which the content has been hosted, or third-party service providers like DMCA.com, which utilize a team of experts to help take down the stolen content for a small fee.
    • In the case of social media intermediaries like Facebook, Instagram or Twitter, content creators can directly approach the platform with proof of them being original creators.
    • Since these companies operate in nations that are signatories to the WIPO treaty, they are obligated to remove the said content if they receive a valid and legal DMCA takedown notice.
    • Platforms, however, also give the other users against whom allegations of content cheating have been made, a chance to reply to the DMCA notice by filing a counter-notice.
    • The platform shall then decide which party is telling the truth and shall accordingly, either restore the content or keep it hidden.

  • MCA raises threshold of Small and Medium Companies

    The Ministry of Corporate Affairs has expanded the turnover and borrowing thresholds for Small and Medium-sized Companies (SMC), allowing a larger number of firms to benefit from reporting exemptions under accounting norms.

    What is the change?

    • The MCA has increased the turnover threshold for SMCs to Rs 250 crore from Rs 50 crore, and the borrowing threshold to Rs 50 crore from Rs 10 crore.
    • SMCs are permitted to avail a number of exemptions under the Company (Accounting Standards) Rule 2021 to reduce the complexity of regulatory filings for smaller firms.
    • Banks, financial institutions, insurance companies, and listed companies cannot be classified as SMCs.
    • Further, any company which is either the holding company or subsidiary of a company that is not an SMC cannot be classified as an SMC.

    What are the exemptions available to SMCs that are not available to other firms?

    • SMC are completely exempted from having to file cash flow statements and provide a segmental break up of their financial performance in mandatory filings.
    • SMCs can also avail partial reporting exemptions in areas including reporting on employee benefits obligations such as pensions.
    • SMCs are exempted from having to provide a detailed analysis of benefit obligations to employees, but are still required to provide actuarial assumptions used in valuing the company’s obligations to employees.
    • SMCs are also exempted from having to report diluted earnings per share in their filings.
    • Diluted earnings per share reflect the per-share earnings of a company assuming that all options to convert other securities into shares are exercised.

    Answer this PYQ in the comment box:

    Q. What is/ are the recent policy initiative(s) of the Government of India to promote the growth of the manufacturing sector?

    1. Setting up of National Investment and Manufacturing Zones.
    2. Providing the benefit of single window clearance.
    3. Establishing the Technology Acquisition and Development Fund.

    Select the correct answer using the codes given below:

    (a) 1 only

    (b) 2 and 3 only

    (c) 1 and 3 only

    (d) 1, 2 and 3

    How does this impact these firms?

    • Experts have noted that the move would promote ease of doing business for the firms that would now be included under the definition of SMC.
    • The Accounting Standards for SMC, which were notified in December 2006 and amended from time to time, are much simpler as compared to Indian Accounting Standards (Ind AS).
    • These accounting standards involve less complexity in their application, including the number of required disclosures being less onerous.
    • Ind AS standards are applied to larger firms and are largely similar to International Financial Reporting Standards (IFRS) used in most developed jurisdictions.

  • Where is the Indian rupee headed?

    The article explains the factors affecting the Indian rupee’s value against the dollar in implications of change in value for the Indian economy.

    Factor’s affecting rupee’s value

    • First, India’s foreign exchange reserves need to be considered, which have been increasing quite rapidly.
    • Second, there are daily fluctuations caused by foreign portfolio investment (FPI) flows.
    • Third, there is the external factor of the dollar, when the US currency strengthens against the euro, the rupee tends to decline and vice-versa.
    • Fourth, there is the concept of the real effective exchange rate (REER), a construct of economists in which relative inflation comes into play.
    • If inflation in India is higher than in countries associated with its export basket of currencies, then the rupee is overvalued and will correct through depreciation.
    • Fifth, at what stage will the RBI intervene by buying or selling dollars to stabilize the Indian currency also matters.

    Let’s look at some of these factors in detail.

    Impact of the U.S. economy and Fed

    • The dollar is driven by the US economy as well as its Federal Reserve’s policies.
    • The Fed’s recent indication that it would raise its policy rate of funds in the years ahead was enough to strengthen the dollar and weaken the rupee.  As an increase in US rates could see global investor money flocking back to the US, the dollar gained in relative value.
    • The dollar should logically be strengthening, given improving US growth, now reinforced by the Fed.

    Inflation factor

    • The inflation factor, however, has been curious.
    • Indian inflation will be high in India and hence also the rupee’s REER.
    • To the extent the market understands this concept and uses it for valuation, it should be pushing the rupee downwards.
    • But the pressure will be less this time as global inflation is also being raised by rising commodity prices.
    • Indian inflation may not be so much higher as to warrant a deep depreciation.

    Increase in Forex reserves

    • An increase in forex reserves is an indication that India is getting in more dollars than we are spending.
    • This also means that our combined current and capital accounts are in surplus zone.
    • However, India’s current account will go into a deficit this year, as imports will be greater than exports, but will not be very high. Maybe 0.5-1% of GDP.
    • The capital account can get tricky.
    • Inward foreign direct investment was high in 2020-21.
    • At $60 billion in equity and $80 billion overall, it was one of the world’s highest.
    • Therefore, capital flows should remain strong.
    • External commercial borrowings could slow down amid weak investment within India.
    • So the fundamentals suggest that the rupee should be stable, with a tilt towards depreciation.

    The RBI intervention

    • The RBI’s surplus liquidity and accommodative stance have not worked in favour of the rupee.
    • In response to its April policy, when RBI affirmed its dovish stance, the rupee began falling on expectations that if RBI kept rates low at a time of high inflation and excessive market borrowing by the government, investors will potentially move out.
    • This pushed the rupee towards the 75 level against the dollar, but reverted with time as RBI kept infusing liquidity and managed the yield curve.
    •  In April, RBI bought $4.2 billion worth of the US currency.
    • Exports have grown smartly in the first two months of 2021-22, and at this stage, the central bank would not want to that trend by stalling the rupee’s depreciation.

    Conclusion

    Taking all these factors into account, one can foresee the rupee moving in the range of ₹74-75 to the dollar, unless there’s a shock of some sort, though none looks likely at present.

  • Microfinance institutions

    The microfinance institutions (MFI) faced several restrictions by RBI which were not applicable to banks, NBFC and small finance banks. This denied the MFIs level playing field. A recent Consultative document by the RBI frees MFIs from such restrictions. The article explains this in detail.

    Background of regulation of MFI’s  by RBI

    • RBI first allowed informal self-help groups to open savings accounts in banks and bank lending to these groups in 1991-92.
    • In 2000, RBI permitted all types of institutions to offer microcredit and bank loans extended to these institutions for on-lending were treated as part of the priority sector lending.
    • Beyond these, RBI was unwilling to bring in any regulations on the plea that as long as these are not deposit-taking institutions there is no need to regulate them. 
    • That was the stand of various RBI-appointed committees too, including the Vyas Committee of 2004.
    • Based on the Malegam Committee recommendations, RBI came out with detailed guidelines for microfinance institutions (not the microfinance sector) in 2011.
    • These guidelines introduced a new category of NBFCs, viz NBFC-MFIs (microfinance institutions).
    • It also set norms for income criteria for clients of MFIs, repayment period, borrower loan limits, interest rate norms and caps, limits on a number of lenders to a borrower and a host of other norms and criteria.

    How these norms created the issue of a level playing field?

    • After 2015-16, the entry of small finance banks, eight of which were MFIs, into the microfinance space started to create issues.
    • MFIs discovered to their dismay that while they had to adhere to a set of regulations, it was a free-for-all for non-MFIs (banks, SFBs and NBFCs).
    • The main issue was that non-MFIs need not adhere to the norm of number of lenders (two in the case of NBFC-MFIs) and per-borrower loan limits.
    • It prompted non-MFIs to target borrowers identified and nurtured by MFIs with higher loan amounts, leading to high levels of borrower indebtedness.
    • In addition, the interest rate cap (2.75 times the base rate declared quarterly by RBI) was squeezing the margins of small and medium MFIs, as none of them get loans from the biggest banks.

    Way forward

    • The recent Consultative Document by RBI frees MFIs from the restriction imposed by the 2011 regulations and gives them a level-playing field.
    • Another important feature for MFIs is that by doing away with the 50% income generation loans criteria and the repayment period norms.
    • RBI is facilitating credit flow into lifecycle needs like housing, water sanitation, education, health, renewable energy, etc, which are now as important as income generation.
    • On the interest rate front, initially, some upward correction could be there by medium and small MFIs based on their borrowing rates.
    • The document enhances the role for the regulator as the adoption of Board-approved policies to determine the norms of household indebtedness and to fix a transparent rate of interest by each institution and their implementation need a rigorous supervisory oversight

    Conclusion

    Providing a level playing field to the MFI is critical to their development, the document by RBI rightly does that. It will help in providing credit to those who remain outside the formal banking network.

    Source:

    https://www.financialexpress.com/opinion/unfettering-microfinance-recent-rbi-consultative-document-frees-mfis-from-shackles-imposed-by-2011-regulations/2277925/

  • Who is a Registered Valuer?

    A valuation report by a registered valuer is at the heart of the recent controversy surrounding a Rs 4,000 crore share allotment decision by PNB Housing Finance.

    Who is a Registered Valuer?

    • A registered valuer is an individual or entity which is registered with the Insolvency and Bankruptcy Board of India (IBIBI) as a valuer in accordance with the Companies (Registered Valuers and Valuation) Rules, 2017.
    • Under Section 458 of the Companies Act, IBBI has been specified as the authority by the central government.
    • The concept of registered valuer was introduced in the Companies Act in 2017 in order to regulate the valuation of assets and liabilities linked to a company and to standardize the valuation procedure in line with global valuation standards.
    • Before the concept of registered valuer became part of the Companies Act, valuation was done in an arbitrary manner, often leading to question marks over the authenticity of the valuation.

    What does the valuation report comprise?

    • As per the Companies (Registered Valuers and Valuation) Rules, 2017, the valuer should, in his/its report, state 11 key aspects including disclosure of the valuer’s conflict of interest, if any.
    • Among others, it must include the purpose of valuation; sources of information; procedures adopted in carrying out the valuation; valuation methodology; and major factors that influenced the valuation.

    Who can become a registered valuer?

    • An individual needs to clear the Valuation Examination conducted by IBBI.
    • The rules state that an individual who has completed 50 years of age and has been substantially involved in at least ten valuation assignments of assets amounting to Rs 5 crore rupees or more, during the five years preceding the commencement of these rules, shall not be required to pass the Valuation Examination.
    • The individual should, however, have a postgraduate degree in the specified discipline (relevant for valuation of the class of asset for which the registration is sought) and should have at least three years of experience in the discipline thereafter.
    • As of March 31, 2021 there were 3,967 registered valuers in the country. Only 40 of them are registered entities; the rest are individuals.

    For what assets can a registered valuer undertake valuation?

    • A registered valuer can get themselves registered for valuation of assets such as land and building; plant and machinery; and securities and financial assets.
    • They can get registered for valuation of all three classes, and can undertake valuation of only the assets for which they have got the registration.

    Answer this PYQ in the comment box:

    Q.Which of the following statements best describes the- term ‘Scheme for Sustainable Structuring of Stressed Assets (S4A)’, recently seen in the news? (CSP 2017)

    (a) It is a procedure for considering the ecological costs of developmental schemes formulated by the Government.

    (b) It is a scheme of RBI for reworking the financial structure of big corporate entities facing genuine difficulties.

    (c) It is a disinvestment plan of the Government regarding Central Public Sector Undertakings.

    (d) It is an important provision in ‘The Insolvency and Bankruptcy Code’ recently implemented by the Government.

  • Bad bank

    The article suggests drawing the lessons from China’s experience with the bad bank as India India gets ready to operationalise a new bad bank.

    Bad bank in China and issues

    • In the aftermath of the Asian financial crisis, China set up dedicated bad banks for each of its big four state-owned commercial banks.
    • These bad banks were meant to acquire non-performing loans (NPLs) from those banks and resolve them within 10 years.
    • In 2009, their tenure was extended indefinitely.
    • Chinese banks can currently transfer NPLs only to the national or local bad banks.
    • One of China’s biggest bad banks is the China Huarong Asset Management Co. Ltd. (Huarong).
    • The Chinese government is its principal shareholder.
    • Recently this bad bank stoked financial stability concerns when it skirted a potential bond default.
    • An incentive to conceal: Recent research at the National University of Singapore and others highlights that Chinese bad banks effectively help conceal Non-Performing Loans.
    • The banks finance over 90 per cent of NPL transactions through direct loans to bad banks or indirect financing vehicles.
    • The bad banks resell over 70 per cent of the NPLs at inflated prices to third parties, who happen to be borrowers of the same banks.
    • The researchers conclude that in the presence of binding financial regulations and opaque market structures bad bank model could create incentives to hide bad loans instead of resolving them.
    • Broadening of tenure: In case of Huarong, the main source of the problem appears to be the gradual broadening of the original mandate and tenure of Chinese bad banks.

    Four lessons for India

    • India is about to operationalise a new bad bank, the National Asset Reconstruction Company Ltd. (NARCL).
    • The Chinese experience holds four important lessons for India.

    1) Finite tenure of bad bank

    • A centralised bad bank like NARCL should ideally have a finite tenure.
    • Such an institution is typically a swift response to an abrupt economic shock (like Covid) when orderly disposal of bad loans via securitisation or direct sales may not be possible.
    • The banks could transfer their crisis-induced NPLs to the bad bank and focus on expanding lending activity.
    • The bad bank in turn can restructure and protect asset value.
    • Over time, it could gradually dispose of the assets to private players.

    2) Narrow mandate

    •  A bad bank must have a specific, narrow mandate with clearly defined goals.
    • Transferring NPLs to a bad bank is not a solution in itself.
    • There must be a clear resolution strategy.
    • Otherwise, allowing a bad bank to exist in perpetuity risks a potential mission creep, which might in the long run threaten financial stability itself.

    3) Diversify the sources of funds for ARC

    • Indian banks remain exposed to these bad loans even after they are transferred to asset reconstruction companies (ARCs).
    • The RBI Bulletin (2021) notes that sources of funds of ARCs have largely been bank-centric.
    • The same banks also continue to hold close to 70 per cent of the total security receipts (SRs).
    • To address this problem, RBI has tightened bank provisioning while liberalising foreign portfolio investment norms.

    4) Resolution of bad loans should be through market mechanism

    • In a steady state, the resolution of bad loans should happen through a market mechanism and not through a multitude of bad banks.
    • In India, the Narasimham Committee (1998) had envisaged a single ARC as a bad bank.
    • Yet, the SARFAESI Act, 2002 ended up creating multiple, privately owned ARCs.
    • As a result, regulations have treated ARCs like bad banks, although functionally they are closer to stressed asset funds registered as Alternative Investment Fund Category II (AIFs).
    • With the setting up of NARCL as a centralised bad bank, the regulatory arbitrage between ARCs and AIFs must end.
    • While AIFs should be allowed to purchase bad loans directly from banks and enjoy enforcement rights under the SARFAESI Act.
    • ARCs should be allowed to purchase stressed assets from mutual funds, insurance companies, bond investors and ECB lenders.
    • ARC trusts should be allowed to infuse fresh equity in distressed companies, within IBC or outside of it.
    • Lastly, the continued interest of the manager/sponsor of ARCs should be at par with AIFs, that is, at least 2.5 per cent in each scheme or Rs 5 crore, whichever is lower.

    Conclusion

    The Chinese experience should nudge Indian policymakers to limit the mandate and tenure of NARCL, while facilitating market-based mechanisms for bad loan resolution in a steady state.